Wrong assumption

TDF 1.0, a first-generation approach, is suboptimal. It uses a fixed glide path that assumes market volatility stays pretty much constant. Witnesses of market meltdowns in 1987, 2000 and 2008 know this assumption is wrong. Furthermore, TDF 1.0 lacks the flexibility to accommodate personal risk preferences or actual cumulative investment results. Nevertheless, RRs need to offer something at least as competitive.

Disciplined asset mix shifts are one aspect of TDFs that beat most RR-based models and wrap accounts that have naive buy-hold-rebalance strategies. Cost is a key driver for portfolio construction.

TDF 1.0 for smaller portfolios

Simplicity is the key for these investors. Ioulia Tretiakova, director of Quantitative Strategies at PUR Investing, rightly points out that “getting the broadest diversification for the money should be a primary goal.

“Investors and advisors who lack the tools to maintain consistent volatility in their portfolios (a feature of TDF 3.0) could use, as a core holding, Claymore’s Balanced Growth Core Portfolio (CBN), which includes BRIC (Brazil/Russia/India/China) and gold exposure with a 17.4% fixed income weight,” she says. “The iShares Growth Core Portfolio Builder (XGR) offers better diversification at a lower fee (0.60% vs. 0.82% for CBN) but with 60% equities and 40% bonds, it’s too conservative for long-dated TDFs.”

Some investors retire when markets are weak. It’s prudent to cash-match needs five years before funds are needed – to pay for college, for example. Zero-coupon bonds are ideal, but availability can be an issue. BMO’s Corporate Bond Target Maturity series helps. Adding these ETFs both pre- and post-retirement is a good way to preserve capital and match cash needs. Income ETFs can be added post-retirement to generate regularly distributed cash.

Next we will consider more sophisticated portfolios that incorporate inflation protection, and suggest ways to control volatility and adjust for actual investment returns.

Mark Yamada is President of PÜR Investing Inc., a software development firm. Disclosure: PÜR Investing Inc. provides risk-based model portfolios to Horizons ETFs.
Originally published on Advisor.ca
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